Section 367(d) transactions, cost sharing arrangements

The IRS Large Business and International (LB&I) division today publicly released a “practice unit”—part of a series of IRS examiner “job aides” and training materials intended to describe for IRS agents leading practices for specific international and transfer pricing issues and transactions—addressing section 367(d) transactions in conjunction with cost sharing arrangements.

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Overview

The practice unit explains that strategic global deployment of high value intangibles has become a frequent form of global tax management. Such intangibles are typically transferred to a related party located in a jurisdiction that imposes little, if any, tax burden on the income from the intangibles.

The IRS observed that some U.S. taxpayers that own high value intangibles may transfer them offshore as part of a strategy to reduce their effective tax rate for financial statement purposes. For example, a U.S. taxpayer may enter into a cost sharing arrangement (CSA) with its controlled foreign corporation (CFC) in a low or no tax jurisdiction and contribute resources, capabilities, and rights (platform contributions) to the CSA.

A platform contribution is any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible development activity (whether prior to or during the course of the CSA) that is reasonably anticipated to contribute to developing cost shared intangibles. Platform contributions can include, but are not limited to, intangibles (as defined by section 936(h)(3)(B)). When the U.S. taxpayer has a platform contribution, the CFC is required to make an arm’s length payment to the U.S. parent for the platform contribution. This transaction is called a “platform contribution transaction.”

Simultaneously with or shortly before entering into a CSA under Reg. section 1.482-7 and providing platform contributions as defined in Reg. section 1.482-7(c)(1), some taxpayers transfer certain intangible property (IP), to their CFC through a section 351 or section 361 transaction, which is a taxable transaction under section 367(d). Under Reg. section 1.367(d)-1T(c)(1), the transferor must report income that "…represents an appropriate arm’s length charge for the use of the property" as "determined in accordance with the provisions of IRC 482 and the regulations thereunder." These taxpayers may value the IP transferred in the section 367(d) transaction separately from the platform contribution transactions that are required under the CSA, even though the IP conveyed in the section 367(d) transaction and the platform contributions will be exploited on a combined basis.

The practice unit states that based on the aggregation principles in the regulations, this non-aggregate approach may not provide an arm’s length result for the section 367(d) transaction and the platform contribution transactions. For example, a platform contribution consisting of the collective knowledge and skill of an R&D team may have value in isolation, but may have greater value when used in combination with in-process R&D transferred in a section 367(d) transaction.

The practice unit further notes that the preamble to the final cost sharing regulations specifically mentions the potential need to aggregate section 367(d) transactions with platform contribution transactions.

“The combined effect of multiple contributions, potentially including controlled transactions outside of the CSA (for example, make-or-sell licenses, or intangible transfers governed by IRC 367(d)), may need to be evaluated on an aggregate basis, where that approach provides the most reliable method of an arm’s length result.”

As further described in the practice unit, taxpayers may also contend that less overall compensation is due for the section 367(d) transaction (as compared to the alternative of transferring the IP in a platform contribution transaction) because the scope of intangible property for purposes of section 367(d) is not as broad as the scope of a platform contribution transaction that includes any resource, capability, or right that is transferred to a CSA.

The practice unit states that the IRS believes that the category of intangible property under section 367(d) is quite broad, and that regardless of whether the taxpayer structures the outbound transfer of rights as a platform contribution transaction or a section 367(d) transaction, there must be arm’s length compensation that reflects the value of the rights transferred. The practice unit illustrates this point in describing the transferor and transferee entering into a CSA shortly after a section 367(d) transaction.

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